Sorry America, Ben Bernanke Still Can Not Save Us

The debate over NGDP targeting is getting even hotter, and it looks as though the its advocates are getting even more strident in their belief that all the Fed needs to do is announce a specific goal for NGDP, and the economy would heal, thanks to an increase in inflation expectations.

The idea is essentially: Increased inflation expectations would cause inflation to rise, and since inflation is the magic killer of debt, then America's debt problem goes away.

I think that if you think about it step by step that the idea that the Fed Chairman can create a self-fulfilling prophesy just by talking is less crazy than it sounds. Consider a scenario in which Bernanke says “I want NGDP to grow faster than 5 percent but slower than 10 percent until it catches up with the pre-crash trend and I’m prepared to do crazy stuff to make it happen.” How do sophisticated investors and large firms react to this announcement? Maybe some people find it non-credible. Maybe most do. But nobody is going to lower their growth and inflation forecasts in response. Some people will raise them. And higher expected inflation and real growth will drive higher actual expected inflation and real growth. As long as Bernanke responds to that by saying “NGDP growth has accelerated exactly as I planned, now I continue to want NGDP to grow faster than 5 percent but slower than 10 percent until it catches up with the pre-crash trend” then the second time around some of the skeptics will become converts and the convergence will continue. The announcement doesn’t need to persuade everyone, or even most people, it just needs to push expectations in the right direction.

That's just too simplistic.

Sure, some firms would react to the announcement by raising growth forecasts. But some firms and consumers might freak out and say that things must be really bad for Ben Bernanke to press the red button and radically alter the approach of the Fed.

And some people would just go super-long commodities, driving up inflation. Remember how commodities moved on September 4, 2010, the day after Bernanke confirmed plans for QE2? Sure, there was no fundamental reason that QE2 should have created huge commodity inflation, but we're talking about expectations here, and on 9/4/2010 we got a really clear example of how speculators react to big announcements.

So to think that the impact of a radical Fed announcement would only go in one direction is not born out by history.

And then there's the problem of the fact that the Fed only has any credibility because the Fed has tools, and it's just not clear that the Fed has the tools to pull off the job. Buying financial assets (mortgages, Treasuries, etc.) won't cause the real-world inflation that businesses and consumers might like to see.

As Goldman -- itself an NGDP targeting advocate -- recently put it in a note:

Of the devices that may be used to buttress the commitment to a new target, several—fiscal policy most obviously, but in the Fed’s case any expansion of the kinds of assets being purchased—would need legislative approval even if the target itself did not.

In other words, the Fed could create inflation by buying up land, houses, orchards, dams, rail systems, workers, etc. but would need to get the permission of Congress first, and, frankly, that won't happen in a million years.

Matt Yglesias does offer another possibility for what the Fed could do in an attempt to refute the idea that in a deleveraging society, offering up more cheap money doesn't do anything.

Right now, I have a mortgage. The interest rate on it is pretty low. But it’s not 1 percent. If the Fed wanted to offer me a loan at a one percent interest rate that would be sufficient in scale to pay off my existing mortgage, that would reduce by debt burden just as easily as a higher income would. Thus far the Fed’s policies have been oriented toward giving free money to banks in hopes that this will circulate down to the little bit, and the circulation has been blocked by a lot of other issues. But a determined central banker can get around this. Direct provision of super-cheap credit would work fine.

First of all, we're not sure that this is even legal, but even if it is, this wouldn't be a game changer, because a loan on an underwater home at a 1% interest rate is still a loan on an underwater home, and that homeowner still has negative equity. We've already seen, since Obama took office, the failure of housing policies that don't fundamentally alter the principle amount owed. More cheap loans isn't the answer.

What America needs is fiscal stimulus: Money from DC into the pockets of debt-strapped homeowners. Everything else is just magical thinking.

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